International news

Smith & Nephew gets more attractive

HesterPlumridge

LONDON--Being small in a world of giants has long cast replacement-joint maker Smith & Nephew PLC in the role of takeover target, but a new European tax crackdown could make it more so.

The European Union this week launched an investigation into the tax practices of U.S. multinational companies such as Starbucks Corp. and Apple Inc. It could spell the end of a U.S. loophole that has allowed some multinational companies to achieve low tax rates on non-U.S. income by locating their intellectual property in low-tax jurisdictions.

If that happens, it could make more sense for U.S. companies to relocate to a country such as the U.K., making the likes of Smith & Nephew even more attractive.

The move would offer an additional spur to consolidation in the orthopedics market where long-term pressures are forcing companies to bulk up. Developed markets offer scant growth and payers are demanding better value. Prices for replacement joints are falling by around 2% a year on average globally, analysts estimate. By offering hospitals packages of products, companies can negotiate better prices.

In May, acquisitive U.S. company Stryker Corp. was forced by U.K. takeover rules to say it didn't intend to make an offer for Smith & Nephew after the company's shares spiked on takeover rumors.

The "put up or shut up" rule means that a potential acquirer must state its intentions immediately and act on them within 28 days. In fact Stryker was still considering its options. It must now wait six months before returning with an offer, unless a rival bidder emerges.

Several could be in the running. A number of companies that were looking at buying Smith & Nephew's rival Biomet Inc., which announced a $13.35 billion sale to Zimmer Holdings Inc. in April, are now reviewing other opportunities in the sector, one senior health-care banker said.

The Zimmer deal to buy Biomet "changed the landscape overnight," according to Sanford C. Bernstein & Co. analyst Lisa Clive, by reducing the number of global players in orthopedics to just four. Few had thought regulators would allow further consolidation and the tie-up still could founder on antitrust concerns.

Buying Smith & Nephew could prove attractive for a U.S. business with cash trapped offshore. The top 10 U.S. medical technology firms are sitting on around $63 billion in cash and short-term investments, much of which is likely offshore, Berenberg estimates.

By relocating to the U.K., a U.S. company could possibly channel future cash generated in Europe through a U.K. holding company and avoid punitive U.S. taxes on repatriated profit.

That could prove a boon to a company like Stryker, which generates around 50% to 60% of its pretax profit outside the U.S., according to estimates from Morgan Stanley.

Therefore, the recent crackdown on U.S. tax anomalies could offer a further incentive for non-European companies to consider foreign M&A.

"If you're a far-thinking U.S. company, you might think, 'These deals are not going to last forever--I'm going to take the opportunity to restructure completely and become a European company,'" said Heather Self, a tax partner at Pinsent and Masons.

Still, tax benefits could prove tricky to achieve for a buyer of Smith & Nephew. Its first-quarter tax rate was 28.9%, compared with Stryker's 24.1%. Although it is based in the U.K., Smith & Nephew is predominantly a U.S. company in terms of its sales, manufacturing, and research and development.

Smith & Nephew declined to comment on bid speculation. Chief Executive Olivier Bohuon told analysts in May he saw the Zimmer deal as defensive, adding that "it is not at all what we, Smith & Nephew, are looking for."

Although Smith & Nephew has recently been underperforming the market in its core business of replacement hips and knees, Mr. Bohuon's strategy to expand into faster-growing countries and higher-margin areas such as sports medicine looks sound. Its shares have risen 50% since he took over in 2011, valuing the company around $16 billion.

"Given Smith & Nephew's impressive development under Olivier Bohuon, a material premium would need to be offered by any potential bidder," said Mick Cooper, an analyst at Edison.

Assuming a 30% takeover premium, a deal to buy Smith & Nephew could top $20 billion--a sizable chunk for any acquirer. Antitrust issues could stymie any tie-up with an orthopedics rival, while a combination with Medtronic would still face the problem of much-larger-scale competitors. Further, a third of Smith & Nephew's revenue comes from wound care--a business few of its rivals are in.

Berenberg's Mr. Jones is skeptical that a deal can emerge. "Smith & Nephew has been a bid target for 46 years," he said, "and we would not be surprised if it still is a target 46 years from now."

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